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Musings from the Oil Patch by Eoin Treacy

Musings from the Oil Patch

Thanks
to a subscriber for this edition of Allen Brooks ever interesting report
for PPHB. Here is a section

Another chart we prepared (Exhibit 12) covered rig activity from the start of 2007 to the end of 2012. When we visually examined the rig activity trend at the end of 2012 and compared it to the collapse in the fall of 2008 and first half of 2009, which coincided with the financial crisis and start of the global recession that crushed oil and gas prices and created severe cash liquidity issues for many companies, there didn't seem to be any comparison in the patterns. We would describe the late 2008 and early 2009 time period as “falling off the cliff.” Just to put that time period into perspective, from mid-September 2008 to mid-March 2009, the total rig count plummeted by 907 rigs, or nearly 45%. That was followed by another three months in which the overall rig count dropped another 22%. The total rig count fell during this period from 2,019 to 868, or a drop of 1,151 rigs. Oil rigs fell by 56% to 183, while gas rigs dropped by 921 rigs to 685. What is very interesting is that from September 2008 to March 2009, oil prices fell from $100 a barrel to $40-45. That certainly would explain the 45% rig count drop. But in the next three months when the rig count seemed to be falling at the same rate as in the earlier period, the oil price rebounded to $70 a barrel. The message of this trend is that while commodity prices may be extremely volatile, the oil and gas industry can't respond quite as quickly. Moreover, no one wants to go through a radical downsizing of its business and then jump back in within a matter of weeks – that would have suggested management was only reacting to events rather than managing around them.

So while the Yahoo! Finance headline writer may think the decline in the rig count over the past few months is like going over a cliff, we suggest he should measure activity against the pattern during the financial crisis. That's a pattern we would call “falling off the cliff.” Let's hope we never see that magnitude of an industry contraction again, although based on the history of the oil and gas business, it will re-occur sometime.

Eoin Treacy's view One of the primary reasons drilling activity
has been so high over the last few years is tied to the desire of energy companies
to secure their leases. As supply of natural gas surged and prices deteriorated
drilling activity declined to only what was strictly necessary. As unconventional
oil projects became viable a considerable number of rigs migrated. WTI
Crude oil has been largely rangebound over the last few months as bottlenecks
in transportation infrastructure have balanced improving perceptions of economic
growth potential.

Just
as stock markets have responded to improving perceptions and a steady flow of
liquidity since the November lows, WTI Crude has also turned upwards and a break
in the short-term progression of higher reaction lows would be required to question
current scope for continued higher to lateral ranging. This improvement is being
mirrored in heating oil and gasoline contracts.

Natural
gas remains in a different pricing environment. A great deal of additional
unconventional supply becomes economic at $4 and this represents a significant
psychological barrier to prices. Natural gas has pulled back to test the six-month
progression of higher major reaction lows and the region of the 200-day MA but
a clear upward dynamic will be required to suggest a return of demand dominance
in this area.

The
WTI Crude Oil / Natural Gas ratio found
support in November near 22.75 and a sustained move below that level would be
required to question oil's potential for further medium-term outperformance

Low
natural gas prices on an absolute and relative basis act as a powerful incentive
to migrate demand from oil and coal. This has already occurred in the utilities
sector and will be a major consideration of chemical, industrial, manufacturing
and infrastructure investment in the USA going forward.

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